Are you currently wondering why you were rejected from a credit card application you just filled out? What have you really wondering is why you can’t get a credit card with, say, a limit of $3000, yet you can qualify for a home renovation loan of $19000. Why the heck can you get a large loan for a home renovation, yet the credit card company has denied you credit. This can be somewhat confusing for people, so I am going to explain why this might happen.
After reading this article, you will understand the difference between a bank loan and a credit card. While both are lines of credit issued by the bank, they are very different in how the bank views the loan.
The first thing you must understand is when you apply for a loan such as a home renovation loan, the issuing bank views the loan as a low-risk loan, meaning they feel very confident that they can recover their money in the event you default on the loan. Defaulting on the loan means you fail to back it back.
In the case of a home renovation loan, the bank will issue the loan more readily than a credit card because the amount borrowed is against the equity in your home. The bank has collateral they can use to recover their costs if you fail to pay it back. Essentially you put your home on the line to secure the loan.
A credit card is still a loan, but the key difference is there is no equity securing the credit card. If you default on a credit card loan, the bank has no equity to recover their costs; therefore, a credit card is a higher risk for the bank, and therefore they are more stringent on their requirements when issuing a credit card.
To help you better understand how credit cards and loans work, read the following overview of banks’ various types of credit.
Types of credit explained:
An installment loan and a credit card have very different financial products, and the approval process the banks use is different for each of these types of credit.
Here is a brief overview of the difference:
Require you to repay a pre-determined amount on a monthly or bi-weekly basis. Your payment is the same at every payment interval.
A credit card is a revolving line of credit that is open-ended. This means you have a maximum amount you can borrow on your card for purchases and those up to you to make. The bank has no collateral to pursue if you fail to make your payments. For example, you can book a vacation on your credit card, and should you not make your payment, and the bank has no recourse to collect the goods purchased.
Now that you understand how each type of credit works, the big difference comes down to how the bank makes its decision to lend money.
Typically, credit cards are unsecured, which means the bank has no equity from you backing up the credit line, hence a greater risk to them. There is no collateral for the bank to pursue in the event you default on your payments. Defaulting on payments means you don’t pay your bills (for those who don’t know the term default means concerning credit).
For example, most installment loans, such as a home improvement loan, are secured by the equity in your home. In this case, the bank’s risk is significantly reduced, making it easier to acquire the loan for you.
The risk assessment the bank performs when lending money also considers how most consumers view debt and the priorities most consumers have when paying off debt.
The average consumer will first make sure they make their mortgage payment and their installment loan payments. Most people consider these to be the most important to pay first, and the last priority is to pay their credit card bill.
Because most consumers place paying their credit card balance last, the risk to the bank is greatly increased. Remember that the bank now has no collateral to back up the loan.
Most people don’t consider their credit card balance in the same way as a loan with set repayment terms, highlighting the need for greater consumer awareness to use their credit cards responsibly.
Consumers often don’t think of credit cards as a loan with re-payment requirements, which ultimately impact a consumer’s credit score, especially when credit cards get abused.
Now you have some background information about how banks view credit card loans versus installment loans, let’s explore applying for a credit card and getting accepted.
Getting the right credit card application
To be accepted for a credit card, you will need to apply for the right offer. Applying for the right credit card requires that you be real with yourself.
You know where you stand financially, so if your credit is bad, avoid applying for low rate and rewards cards as, in most cases, these are for only those with good to excellent credit.
I tell you to apply for the right credit card because each time you apply for credit and get rejected, your credit score slips. When your credit score slides, the odds of qualifying for the next application are diminished, so make sure you apply for the right card the first time.
If you truly don’t know your current credit situation, I suggest that you order your credit report or, better yet, schedule an appointment with your bank to get a true understanding of where your finances are.
Tips for choosing an application
There are literally thousands of card offers available with many different features and rewards. Each card is designed for a particular demographic. Yes, the bankers are smart people and want to create financial products to serve every personal interest.
Here are some tips for you to choose the best credit card for your life situation and interests.
Those with good to excellent credit:
How do you want to be rewarded? Credit card companies have many reward cards designed to serve every interest or need you to have. For example, there are tons of travel rewards cards, so if you are a frequent traveler, then a card with hotel or airline rewards might be perfect for you. Perhaps you spend a lot of time driving and could use a break on gasoline price, then apply for a credit card with gas rewards.
People with fair to poor credit
You likely will not qualify for a card with all the perks, so you will want to consider credit cards with the lowest possible interest rates and lowest annual fees. Because people with bad credit present a greater risk to the bank, the risk is offset by charging higher interest rates and bank fees. I have reviewed credit card applications for people with bad credit that have some of the lowest fees. If you have bad credit, my advice is to apply for one of these cards and use the card very sparingly and make sure you pay at least your minimum balance every month. Use these cards only as a mechanism to boost your credit score, then transfer your balance to a low rate credit card when your credit score has been increased.